Here's Why Kukdong (KRX:005320) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Kukdong Corporation (KRX:005320) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kukdong

What Is Kukdong's Net Debt?

As you can see below, at the end of September 2020, Kukdong had ₩64.1b of debt, up from ₩39.2b a year ago. Click the image for more detail. But it also has ₩85.3b in cash to offset that, meaning it has ₩21.2b net cash.

How Healthy Is Kukdong's Balance Sheet?

We can see from the most recent balance sheet that Kukdong had liabilities of ₩78.0b falling due within a year, and liabilities of ₩25.5b due beyond that. Offsetting this, it had ₩85.3b in cash and ₩28.3b in receivables that were due within 12 months. So it actually has ₩10.2b more liquid assets than total liabilities.

This surplus suggests that Kukdong has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Kukdong has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Kukdong turned things around in the last 12 months, delivering and EBIT of ₩34b. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kukdong will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Kukdong may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last year, Kukdong produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kukdong has net cash of ₩21.2b, as well as more liquid assets than liabilities. So we don't have any problem with Kukdong's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Kukdong (including 1 which is doesn't sit too well with us) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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